Opportunities In The Decimated Aerospace Value Chain

During their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed Opportunities In The Decimated Aerospace Value Chain. Here’s an excerpt from the episode:

Bill: I think the aerospace value chain, because it’s super decimated as many of you may know, all 10 of you. I had a good conversation with a buddy that works at Boeing last night. And just the amount of slack that is in Boeing’s system right now, he was telling me that at some point they were talking about maybe producing eighty 737 MAXs a month and now, they’re looking at, I mean, it’s almost stopped right now. But you’re looking at— I think 30 is the number that I heard is the plan. And just how that trickles through the supply chain, like Spirit AeroSystems delivers them. They refer to it as shipsets, I think it’s fuselages and wings for the most part. And Boeing was paying Spirit– or had agreed to have Spirit produce like 50 to 55 last year, even though the MAX was ramping down production. So there was already excess inventory in that system that had to be worked off. And now this, so it’s just been a pileup of issues. I need to get like a deck together and sort through my thoughts. It fits nicely within the acquisition project that I’m doing because you’ve got like TransDigm or Heico, or within the space.

But it’s been interesting, the security that is pretty interesting to me or a set of securities is united bonds actually. You get a lot of yield. You’re higher in the capital structure. It’s the operating entity or the holdco rather, so you’re not secured by the airplanes, but you also don’t have the equity risk. All that they’re talking about is prudent management and paying down debt. Scott Kirby’s a G, that guy knows how to run an airline. They got a lot of cash right now, they got about 250 days of cash burning $20 million a day, so obviously by the end of the fourth quarter, but you gotta assume that they’re gonna get some delay or some traffic coming back, which these riots probably aren’t helping very much, but that one’s interesting to me. And then I’m going through all of them. But I have to think that there’s some value somewhere in there. From a high level, just thinking about how valuation occurs and is built and whatever.

The truth of the aerospace supercycle is going to continue into perpetuity, that was obviously flawed in December. But it is also not as bad as it feels today. That’s normalization, and there’s no visibility right now. So, the idea that people are not going to get more amped up about it over time, I think is almost– the probability is almost zero and that’s going to reflect in the models. You’re not buying into a rosy outlook is the short story. And I think if you got some companies that can survive, you got a reasonable shot at having a pretty good puff in three to five years.

Tobias: And so, you’re moving up the cap stack a little bit to get the debt because it’s got a fatter yield rather than sitting in the equity?

Bill: I’m thinking about it, yeah. United, you’re looking at 11% to 13% yields to maturity for a couple years. Out to 2022, I think it’s 13.3% or something. And it’s an equity hybrid security. It’s not safe, but it’s a whole lot safer than the equity, and you get a pretty good yield there. So, it’s how I’m thinking about that particular part of the value chain. But I’m thinking about stuff like Hexcel, they make composites that are taking greater share of airplanes in general. They also sell into windmills. I don’t know enough to talk about the entities, but I’m trying to work through like, where’s the kink? And I think just from a capital cycle theory standpoint, three to five years out, this shit is going to be tight. I mean they’re firing all their labor, they’re gonna be lean. If you think about, “Okay, how’s this look in a couple years?”, I need to figure out where the profits are gonna flow, but they’re gonna flow somewhere. The supply chain is not gonna be stopped forever.

Tobias: That’s a bold take.

Bill: Well, you don’t have to have the smartest take in the room, you just gotta be right.

Tobias: I hold love and SPO equity.

Bill: You got Spirit?

Tobias: I got Spirit, yeah. That’s worked out okay.

Bill: They are decimated right now. I think their stock’s off like 70%. It’s just one of those things like, just from a gut check—and I know that without doing the math, I get that I’m just talking out of my ass here, but what’s the probability that the value of a perpetual asset has changed 70% in three months? I would say almost zero. So now you get into questions like, was it valued properly before? Is it valued properly now? I don’t know. What I do know is if you’re trying to stack the odds in your favor, looking in areas like this seems to be a better way to stack the odds in your favor than buying whatever Jimmy Chill recommended.

Jake: Does the– M&A component of that when you talk about TransDigm or Heico, is that that you just think they’re going to have a richer opportunity set here over the next couple years of stuff that they can buy?

Bill: I don’t know. You get into a problem with size with both those entities. It is easier to build through M&A on a small base than a larger base. But I think the idea that the big don’t find some people to swallow up is hard for me to fathom because I gotta think if they’re struggling, everyone is struggling.

Tobias: When do we normalize?

Bill: Hexcel, they called off a merger recently. Does that restart down the road? I don’t know, but that’s what my research project is right now.

Tobias: When do we normalize? How do you think about that?

Bill: I don’t know, man. I mean, anyone that knows, they’re just lying. So, there are a lot of competing thoughts that I have. One is, airlines are gonna retire these older aircraft before they have heavy maintenance because they don’t want to incur the cash outflow. The other side of that is United is saying, “We have a young fleet. We’re not gonna buy new airplanes right away. So, we’re gonna stretch out our fleet age,” which is what Delta did, pretty much from ‘09 to today. They took a week and improved our cabins but not our fleet, and that worked out. I don’t know how it all shakes out. I really don’t. What I am confident saying is wide body will come back slower than narrow bodies. So, the 737 and the A320 is gonna come back quicker than the dual aisle transcontinental stuff.

Tobias: I think it comes back pretty quickly and I’ll tell you why. I’ve sent you guys that chart on mobility and what that chart shows we’re basically back to baseline for walking and for driving. So, the peaks now look like the troughs previously and that was a few weeks ago, so we’re probably now getting back to baseline. Public transport still basically zeroed out, but I’m not sure how much public transport is actually running. Where you fit flights in that is a little bit harder. It’s not public transport necessarily, but it’s also not driving your own car, you’re not as safe as that. 9/11 equalized in about three months, normalized in about three months. Even if it’s not three months, that’s still– we’re a pretty adaptable species, we forget really quickly.

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